It is well known that financial analysts can move stock prices through their investment recommendations and other information they publicly release.

In new research that underscores the importance of such analysts to firms, Pamplin College of Business finance assistant professor Ambrus Kecskes and coauthor Francois Derrien, of business school HEC Paris, show that the loss of analyst coverage of a firm hurts its investment and financing. 

“Loss of analyst coverage is a type of financial shock to a firm,” Kecskes says.

Their study is the first to show that changes in analyst coverage cause changes in corporate policies. “While most practitioners consider it obvious that analysts affect the firms that they cover,” Kecskes says, “there has been little scientific evidence that analysts affect firms directly.”

Sell-side research analysts, he says, “are one of Wall Street’s main producers of information for the general investing public.” These analysts typically work for investment banks, which match investors — the savers of capital — with firms — the users of capital.

“The reports that analysts produce to help investors also helps the firms that the analysts monitor,” he says. “And the better the analyst is at his job, the more significantly firms change their financing and investment behavior.”

Kecskes and Derrien looked specifically at analyst departures — for example, retirements or terminations — resulting from the closures or mergers of their investment banks.

The researchers examined how firms behave after these “essentially random” analyst departures. “We conjectured that after an analyst leaves, investors have less information upon which to base their buy or sell decisions of the firms in question,” says Kecskes.

“Consequently, investors will demand a higher return on their investment in these firms, and the firms, in turn, will face higher costs of financing in the capital markets.”

This has two major consequences for the firms. “First, firms will tend to finance themselves to a greater extent with internal funds that they generate than external funds that they raise from their creditors and owners — because doing so is cheaper.

“Second, firms will tend to invest less — because investment projects, such as developing drugs or building houses, are less profitable in light of the now higher costs that firms have to pay to finance them.”

The data not only supports this line of thinking, he says, but the results are more pronounced for firms that are smaller, more financially constrained, and followed by fewer analysts.

His and Derrien’s study, “The real effects of financial shocks: Evidence from exogenous changes in analyst coverage,” will be published in the Journal of Finance.

Kecskes, who specializes in corporate finance and investment, received Pamplin’s 2013 Junior Faculty Award for Excellence in Research. His work has been cited in the Wall Street Journal, the Chicago Tribune, and other media.

Read the full story about this study and other new investing research by Kecskes in the spring 2013 Pamplin magazine.



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